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ACME PACKET INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statement
This Quarterly Report on Form 10-Q, including the information incorporated by
reference herein, contains, in addition to historical information,
forward-looking statements. We may, in some cases, use words such as "project,"
"believe," "anticipate," "plan," "expect," "estimate," "intend," "continue,"
"should," "would," "could," "potentially," "will," "may" or similar words and
expressions that convey uncertainty of future events or outcomes to identify
these forward-looking statements. Forward-looking statements in this Quarterly
Report on Form 10-Q may include statements about:
• our ability to attract and retain customers;
• our ability to retain and hire necessary employees and appropriately staff
our operations;
• our financial performance;
• our expectations regarding our revenue, cost of revenue and our related
gross profit and gross margin;
• our development activities, expansion of our product offerings and the
emerging opportunities for our solutions;
• our position in the session delivery network solutions market and our competitors;
• the effect of the worldwide economy on the demand of our products;
• the expectations about our growth and acquisitions of new technologies;
• the demand for and the growth of worldwide revenues for session delivery network solutions;
• the benefit of our products, services, or programs;
• our ability to establish and maintain relationships with key partners and
contract manufacturers;
• potential natural disasters in locations where we, our customers, or our
suppliers operate;
• the advantages of our technology as compared to that of our competitors;
• our expectations regarding the realization of recorded deferred tax
assets; and
• our cash needs.
The outcome of the events described in these forward-looking statements is
subject to known and unknown risks, uncertainties and other factors that could
cause actual results to differ materially from the results anticipated by these
forward-looking statements. These important factors include our financial
performance, our ability to attract and retain customers, our development
activities and those factors we discuss in this Quarterly Report on Form 10-Q
and in our Annual Report on Form 10-K under the caption "Risk Factors." You
should read these factors and the other cautionary statements made in this
Quarterly Report on Form 10-Q as being applicable to all related forward-looking
statements wherever they appear in this Quarterly Report on Form 10-Q. These
risk factors are not exhaustive and other sections of this Quarterly Report on
Form 10-Q may include additional factors which could adversely impact our
business and financial performance.
Overview
Acme Packet, Inc. is the leader in session delivery network solutions which
enable the trusted, first class delivery of next-generation voice, video, data
and unified communications services and applications across Internet Protocol,
or IP, networks.
A session delivery network helps individuals and organizations overcome the
limitations inherent in using the Internet, or other best-efforts, unsecured IP
networks, for session-based voice, video, data, unified communications and
collaboration. A session delivery network "layers" complementary intelligence
and controls "over" an IP transport network composed of IP routers and Ethernet
switches. With the IP transport network providing basic packet routing and
delivery services, the "overlay" session delivery network provides critical
session border control and session management functions that ensure prioritized,
secure and trusted delivery of a broad range of services and applications
encompassing voice, video, data, and unified communications and collaboration.
Session delivery networks are comprised of several different product categories
that work together to deliver trusted, first class services and applications.
Acme Packet is the world's leading provider of session border controllers, or
SBCs, that are the cornerstones of session delivery networks. SBCs control
session delivery across defined border points where IP networks connect, known
as network borders. SBCs are deployed at network borders between two service
providers or between a service provider and its enterprise, residential or
mobile customers.
In addition to SBCs, session delivery networks need additional products to
perform critical roles:
• Session manager, or SM, manages user access and interface application
servers;
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• Multiservice security gateway, or MSG, secures session delivery of data
and voice services over untrusted Internet and wireless fidelity, or WiFi,
access networks;
• Diameter signaling controller, or DSC, controls diameter signaling within
long-term evolution, or LTE, networks and enable LTE data and voice
session roaming;
• Session-aware load balancer, or SLB, scales border control for SBC, MSG
and DSC deployments;
• Session routing proxy, or SRP, routes sessions to and from access and
interconnect borders;
• Application session controller, or ASC, enables Web 2.0 server
applications to initiate and control sessions; and
• Session recorder, or SR, performs session recording for the session
delivery network.
Acme Packet's session delivery network solutions are used by over 1,600 Acme
Packet customers in 108 countries. Our customers include fixed line, cable,
mobile, transit and over-the-top, or OTT, communication service providers, as
well as enterprises, contact centers and government organizations.
We sell our products and support services through over 230 distribution partners
and through our direct sales force. Our distribution partners include many of
the largest networking and IP communications equipment vendors throughout the
world.
Our headquarters are located in Bedford, Massachusetts. We maintain sales
offices in Beijing, China; Ipswich, United Kingdom; Madrid, Spain; Moscow,
Russia; Seoul, South Korea and Tokyo, Japan. We also have sales and support
personnel in Argentina, Australia, Belgium, Brazil, Canada, Columbia, Croatia,
Czech Republic, France, Germany, Hong Kong, India, Indonesia, Israel, Italy,
Malaysia, Mexico, the Netherlands, New Zealand, Peru, Poland, Saudi Arabia,
Singapore, South Africa, Sweden, Taiwan, Thailand, United Arab Emirates and
throughout the U.S. We expect to selectively add personnel to provide additional
geographic sales and technical support coverage.
Industry Background
Service providers traditionally have delivered voice and data services over two
separate networks: the public switched telephone network, or PSTN, and the
Internet. Similarly, enterprises have traditionally used the PSTN for voice
services and the Internet for data applications. The PSTN provides high
reliability and security but is costly to operate and is limited in its ability
to support high bandwidth video and other interactive multimedia services. The
Internet is capable of cost effectively transmitting any form of traffic that is
IP-based, including interactive voice, video and data, but it transmits traffic
only on a best efforts basis, because all forms of traffic have the same
priority. Therefore, the Internet attempts to deliver all traffic without
distinction, which can result in significantly varying degrees of service
quality for the same or similar types of traffic transmissions. Internet based
services are also subject to disruptive and fraudulent behavior, including
identity theft, viruses, unwanted and excessively large input data, known as
SPAM, and the unauthorized use and attempts to circumvent or bypass security
mechanisms associated with those services, known as hacking.
Both service providers and enterprises are migrating to a single IP network
architecture to serve as the foundation for their next generation voice, video,
multimedia and data services and applications. In order to provide trusted,
secure and high quality interactive communications on a converged IP network,
service providers and enterprises must be able to control the communications
flows that comprise communication sessions.
Evolution to a Converged IP Network
IP networks can be designed and operated more cost effectively than the PSTN. In
addition, IP networks are capable of delivering converged voice, video and data
services and applications. Service providers are seeking to provide these
next-generation services to enhance their profitability by generating
incremental revenue and by reducing subscriber turnover. Enterprises are
searching for ways to unify their communications by seamlessly integrating
voice, video, instant messaging and collaboration while reducing costs. Managing
two distinct networks, the PSTN and an IP network, is not a viable economic
alternative. As a result, service providers and enterprises have begun to
migrate to a single IP network architecture to serve as the foundation for their
next-generation services and applications. In order to successfully transition
to a single IP network, however, they must maintain the same reliability,
quality and security that have for decades exemplified their delivery of voice
services.
Challenges of IP Networks in Delivering Session-based Communications
IP networks were designed initially to provide reliable delivery of data
services such as file downloads and website traffic that are not sensitive to
latency or time delay. If data packets are lost or misdirected, an IP network
exhibits tremendous resiliency in re-transmitting and eventually executing the
desired user request, which generally is an acceptable result for these types of
data services. However, IP networks historically have not been capable of
guaranteeing real time, secure delivery of high quality sessions-based
communications such as interactive voice and video.
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A session is a communications interaction that has a defined beginning and end,
and is effective only when transmitted in real time without latency or delays.
In order to enable a session-based communication, control of the session from
its origination point to its defined end point is required. No single IP network
extends far enough to enable that level of control and the Internet lacks the
fundamental quality of service and security mechanisms necessary to consistently
deliver the security and quality of real time multimedia communications that
consumers and businesses require. In order to gain the trust of users, service
providers and enterprises must be able to assure secure and high quality
interactive communications across one or more networks.
Key Financial Statistics
Some of our key financial statistics for the first quarter of 2012, as compared
to the same metric for the first quarter of 2011, include the following:
• Total revenue was $70.8 million compared to $74.0 million,
• Net income was $2.4 million compared to $13.7 million,
• Earnings per share was $0.03 per share on a diluted basis compared to
$0.19 per share on a diluted basis,
• Cash provided by operating activities was $26.7 million compared to
$11.5 million, and
• Cash provided by financing activities was $6.5 million compared to
$20.0 million.
The Acme Packet Strategy
Principal elements of our strategy include:
• Continuing to satisfy the evolving session delivery network requirements
of enterprises and fixed-line, mobile and OTT service providers. Our
network deployments position us to gain valuable knowledge that we can use
to expand our product portfolio and enhance our products' features and
functionality. We may develop new products organically or through
selective acquisitions.
• Implementing new technologies to enhance product performance and
scalability. We will seek to leverage new technologies as they become
available to increase the performance, capacity and functionality of our
product family, as well as to reduce their costs.
• Investing in quality and responsive support. As we broaden our product
family and increase the capabilities of our session delivery network
solution, we will continue to provide comprehensive service and support
targeted at maximizing customer satisfaction and retention.
• Facilitating and promoting service interconnects and federations among our customers. We intend to drive increased demand for our products by helping
our customers to extend the reach of their services and applications and,
consequently, to increase the value of their services to their users.
• Leveraging distribution partnerships to enhance market penetration. We
will continue to invest in training and tools for our distribution
partners' sales, systems engineering and support organizations, in order
to improve the overall efficiency and effectiveness of these partnerships.
• Actively contributing to architecture and standards definition processes.
We will utilize our breadth and depth of experience with session delivery
network deployments to contribute significantly to organizations
developing standards and architectures for next generation IP networks.
Factors That May Affect Future Performance
• Global Macroeconomic Conditions. We believe that the capital budgets and
spending initiatives of some of our core customers - service providers,
enterprises, government agencies and contact centers - may be affected by
ongoing worldwide economic conditions. Our ability to generate revenue
from these core customers is dependent on the status of such budgets and
initiatives.
• Gross Margin. Our gross margin has been, and will continue to be, affected
by many factors, including (a) the demand for our products and services,
(b) the average selling price of our products, which in turn depends, in
part, on the mix of product and product configurations sold, (c) the level
of software license upgrades, (d) the cost of acquiring our products for
sale, (e) new product introductions, (f) the mix of sales channels through
which our products are sold, and (g) the costs of manufacturing our
hardware products and providing our related support services. Customers
license our software in various configurations depending on each
customer's requirements for session capacity, feature groups and
protocols. The product software configuration mix will have a direct
impact on the average selling price of the system sold. Systems with
higher software content (higher session capacity, support for higher
number of security protocols and a larger number of feature groups) will
generally have a higher average selling price than those systems sold and
licensed with lower software content. If customers begin to purchase
systems with lower software content, this may have a negative impact on
our revenue and gross margins.
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• Competition. Competition in our product categories is strong and
constantly evolving. While we believe we are currently the market leader
in the service provider and enterprise markets for session delivery
network solutions, we expect competition to persist and intensify in the
future as the market grows. Our competitors vary by market segment and product category. In the service provider market, our primary competitors
include GENBAND Inc., Telefonaktiebolaget LM Ericsson, Huawei Technologies
Co., Ltd., Metaswitch Networks Ltd. and Sonus Networks Inc. In the
enterprise market segment, our primary competitor is Cisco Systems, Inc.
We believe we compete successfully with all of these companies based upon
our experience in interactive communications networks, the breadth of our
applications and standards support, the depth of our border control
features, the demonstrated ability of our products to interoperate with
key communications infrastructure elements and our comprehensive service
and support. We also believe our products are priced competitively with our competitors' offerings. As the session delivery network solutions
market opportunity grows, we expect competition from additional networking
and IP communications equipment suppliers, including distribution
partners.
• Evolution of the Session Delivery Network Solutions Market. The market for
our products is still evolving, and it is uncertain whether these products
will continue to achieve and sustain high levels of demand and market
acceptance. Our success will depend, to a substantial extent, on the
willingness of interactive communications service providers and
enterprises to continue to implement our solutions. Demand is also dependent upon the respective geographic regions where our customers are
located. For example, in 2011, we experienced a level of demand that was
lower than we had expected from our service provider customers in North
America, which had an adverse effect on our operations.
• Research and Development. To continue to achieve market acceptance for our
products, we must effectively anticipate and adapt, in a timely manner, to
customer requirements and must offer products that meet changing customer
demands. Prospective customers may require product features and
capabilities that our current products do not have. The market for session
delivery network solutions is characterized by rapid technological change,
frequent new product introductions, and evolving industry requirements. We
intend to continue to invest in our research and development efforts,
which we believe are essential to maintaining our competitive position.
• Managing Growth. We significantly expanded our operations in 2011 and the
first three months of 2012. During the period from January 1, 2011 through
March 31, 2012 we increased the number of our employees and full time
independent contractors by 34%, from 570 to 764. We anticipate that further expansion of our infrastructure and headcount will be required to
achieve planned expansion of our product offerings, projected increases in
our customer base and anticipated growth in the number of product
deployments. In the future, we expect to continue to carefully manage the
increase of our operating expenses based on our ability to expand our
revenues, the expansion of which could occur organically or through future
acquisitions.
Revenue
We derive product revenue from the sale of our Net-Net hardware and the
licensing of our Net-Net software. We generally recognize product revenue at the
time of product delivery, provided all other revenue recognition criteria have
been met. For arrangements that include customer acceptance or other material
non-standard terms, we recognize revenue after acceptance or when the
non-standard terms are resolved, assuming all other criteria for revenue
recognition have been met.
We generate maintenance, support and service revenue from (a) maintenance
associated with software licenses, (b) technical support services for our
software product, (c) hardware repair and maintenance services,
(d) implementation, training and consulting services and (e) reimbursable travel
and other out-of-pocket expenses.
We offer our products and services indirectly through distribution partners and
directly through our sales force. Our distribution partners include networking
and telecommunications equipment vendors throughout the world. Our distribution
partners generally purchase our products after they have received a purchase
order from their customer and, generally, do not maintain an inventory of our
products in anticipation of sales to their customers. Generally, the pricing
offered to our distribution partners will be lower than to our direct customers.
The product configuration, which reflects the mix of session capacity, signaling
protocol support and requested features, determines the price for each product
sold and licensed. Customers can purchase our products in either a standalone or
high availability configuration and can license our software in various
configurations, depending on the customers' requirements for session capacity,
functionality and protocols. The product software configuration mix will have a
direct impact on the average selling price of the system sold. As the market
continues to develop and grow, we expect to experience increased price pressure
on our products and services.
We believe that our revenue and results of operations may vary significantly
from quarter to quarter as a result of long sales and deployment cycles,
variations in customer ordering patterns, and the application of complex revenue
recognition rules to certain transactions. Some of our arrangements with
customers include clauses under which we may be subject to penalties for failure
to meet specified performance obligations. We have not incurred any such
penalties to date.
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Cost of Revenue
Cost of product revenue consists primarily of (a) third party manufacturers'
fees for purchased materials and services, combined with our expenses for
(b) salaries, wages and related benefits for our manufacturing personnel,
(c) related overhead, (d) provision for inventory obsolescence, (e) amortization
of intangible assets and (f) stock-based compensation. Amortization of
intangible assets represents the amortization of developed technologies from our
acquisitions of Covergence Inc. and Newfound Communications, Inc., or Newfound
Communications.
Cost of maintenance, support and service revenue consists primarily of
(a) salaries, wages and related benefits for our support and service personnel,
(b) related overhead, (c) billable and non-billable travel, lodging, and other
out-of-pocket expenses, (d) material costs consumed in the provision of services
(e) stock-based compensation and (f) warranty costs.
Gross Profit
Our gross profit has been, and will be, affected by many factors, including
(a) the demand for our products and services, (b) the average selling price of
our products, which in turn depends, in part, on the mix of product and product
configurations sold or licensed, (c) the mix between product and service
revenue, (d) the cost of acquiring our products, (e) new product introductions,
(f) the mix of sales channels through which our products are sold, (g) the
volume and costs of manufacturing our hardware products, (h) the costs
associated with fulfilling our maintenance and warranty obligations, and
(i) personnel and related costs for manufacturing, support and services.
Operating Expenses
Operating expenses consist of sales and marketing, research and development,
general and administrative, and merger and integration-related expenses.
Personnel related costs are the most significant component of our operating
expenses. During the period from January 1, 2011 through March 31, 2012, we
increased the number of our employees and full time independent contractors by
36%, from 486 to 660. We expect to continue to hire new employees to support our
anticipated growth.
Sales and marketing expense consists primarily of (a) salaries and related
personnel costs, (b) commissions and bonuses, (c) travel, lodging and other
out-of-pocket expenses, (d) marketing programs such as trade shows,
(e) stock-based compensation and (f) other related overhead. Commissions are
recorded as expense when earned by the employee. We anticipate that sales and
marketing expense will remain relatively consistent as a percentage of revenue
in the future.
Research and development expense consists primarily of (a) salaries and related
personnel costs, (b) payments to suppliers for design and consulting services,
(c) prototype and equipment costs relating to the design and development of new
products and enhancement of existing products, (d) quality assurance and
testing, (e) stock-based compensation and (f) other related overhead. To date,
all of the costs related to our research and development efforts have been
expensed as incurred as technological feasibility is determined at the same time
as release. We intend to continue to invest in our research and development
efforts, which we believe are essential to maintaining our competitive position.
We expect research and development expense to increase in absolute dollars.
However, we anticipate that research and development expense will modestly
increase as a percentage of total revenue in the future.
General and administrative expense consists primarily of (a) salaries, wages and
personnel costs related to our executive, finance, human resource and
information technology organizations, (b) accounting and legal professional
fees, (c) expenses associated with uncollectible accounts, (d) stock-based
compensation and (e) other related overhead. We expect general and
administrative expense to increase in absolute dollars as we invest in
infrastructure to support continued growth and incur ongoing expenses related to
being a publicly-traded company. However, we anticipate that general and
administrative expense will remain relatively consistent as a percentage of
total revenue in the future.
Merger and integration related expenses consist of transaction expenses related
to business acquisitions and consist of costs related to professional service
fees related to the acquisition.
Stock-Based Compensation
Cost of revenue and operating expenses include stock-based compensation expense.
We expense share-based payment awards with compensation cost for share-based
payment transactions measured at fair value. For the three months ended
March 31, 2012 and 2011, we recorded expense of $13.7 million and $6.8 million,
respectively, in connection with share-based payment awards. Based on
share-based awards granted from 2007 through 2012, a future expense of
non-vested options of $119.0 million is expected to be recognized over a
weighted-average period of 2.75 years.
Other Income (Expense)
Other income consists primarily of gains or losses from foreign currency
translation adjustments of our international activities. The functional currency
of our international operations in Europe and Asia is the U.S. dollar.
Accordingly, all assets and liabilities of these international subsidiaries are
re-measured into U.S. dollars using the exchange rates in effect at the balance
sheet date, or historical rate, as appropriate. Revenue and expenses of these
international subsidiaries are re-measured into U.S. dollars at the average
rates in effect during the period. Any differences resulting from the
re-measurement of assets, liabilities and operations of the European and Asian
subsidiaries are recorded within other income. Other income also includes
interest income earned on cash, cash equivalents and investments. We have
invested cash in high quality securities and are not materially affected by
fluctuations in interest rates.
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Application of Critical Accounting Policies and Use of Estimates
Our financial statements are prepared in accordance with accounting principles
generally accepted in the U.S. The preparation of these financial statements
requires that we make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting periods. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances. We evaluate our estimates and assumptions on an ongoing
basis. Our actual results may differ significantly from these estimates under
different assumptions or conditions. There have been no material changes to
these estimates for the periods presented in this Quarterly Report on Form 10-Q.
For a detailed explanation of the judgments made in these areas, refer to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our Annual Report on Form 10-K for the year ended December 31,
2011, which we filed with the Securities and Exchange Commission, or SEC, on
February 17, 2012.
We believe that our significant accounting policies, which are more fully
described in the notes to our unaudited condensed consolidated financial
statements included in this Quarterly Report on Form 10-Q, have not materially
changed from those described in the notes to our audited consolidated financial
statements included in our Annual Report on Form 10-K for the year ended
December 31, 2011.
Results of Operations
Comparison of Three Months Ended March 31, 2012 and 2011
Revenue
Three Months Ended March 31,
2012 2011
Percentage Percentage Period-to-Period
of Total of Total Change
Amount Revenue Amount Revenue Amount Percentage
(dollars in thousands)
Revenue by Type:
Product $ 53,464 75 % $ 59,742 81 % $ (6,278 ) (11 )%
Maintenance, support and service 17,366 25 14,225 19 3,141 22
Total revenue $ 70,830 100 % $ 73,967 100 % $ (3,137 ) (4 )
Revenue by Geography:
United States and Canada $ 43,815 62 % $ 44,602 60 % $ (787 ) (2 )
International 27,015 38 29,365 40 (2,350 ) (8 )
Total revenue $ 70,830 100 % $ 73,967 100 % $ (3,137 ) (4 )
Revenue by Sales Channel:
Direct $ 39,769 56 % $ 37,449 51 % $ 2,320 6
Indirect 31,061 44 36,518 49 (5,457 ) (15 )
Total revenue $ 70,830 100 % $ 73,967 100 % $ (3,137 ) (4 )
The $6.3 million decrease in product revenue was primarily due to a decrease in
the average selling price of our systems due to changes in our product software
configuration mix, including software upgrades, the mix of system platforms
purchased by our customers and the sales channels through which they are sold.
The product configuration, which reflects the mix of session capacity support
for signaling protocols and requested features, determines the prices for each
system sold. Customers can license our software in various configurations,
depending on requirements for session capacity, feature groups and protocols.
The product software configuration mix has a direct impact on the average
selling price of a system sold. Systems with higher software content (driven by
higher session capacity support, higher number of signaling protocols or a
higher number of feature groups) will generally have a higher average selling
price than those systems sold with lower software content. This decrease was
partially offset by a slight increase in the number of systems sold. The decline
in product revenue was primarily due to our indirect sales channel, partially
offset by an increase in our direct sales channel. Indirect product revenues
decreased $7.6 million, due to a $4.7 million decrease attributable to our
customers in the U.S. and Canada as well as a decrease of $2.8 million related
to our international customers. Direct product revenues increased $1.3 million,
primarily due to an increase of $1.9 million attributable to customers in the
U.S. and Canada partially offset by a decrease of $616,000 related to our
international customers.
Maintenance, support and service revenue increased by $3.1 million, primarily
due to increases in maintenance and support fees associated with the growth of
our installed product base. Indirect maintenance, support and service revenues
increased $2.1 million, primarily due to an increase of $1.3 million related to
our customers in the U.S. and Canada as well as an increase of $876,000
attributable to our international customers. Direct maintenance, support and
service revenues increased $1.0 million primarily due to a $771,000 increase
attributable to our customers in the U.S. and Canada as well as an increase of
$235,000 attributable to our international customers.
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Cost of Revenue and Gross Profit
Three Months Ended March 31,
2012 2011
Percentage Percentage Period-to-Period
of Related of Related Change
Amount Revenue Amount Revenue Amount Percentage
(dollars in thousands)
Cost of Revenue:
Product $ 9,978 19 % $ 9,945 17 % $ 33 * %
Maintenance, support and service 3,958 23 3,006 21 952 32
Total cost of revenue $ 13,936 20 $ 12,951 18 $ 985 8
Gross Profit:
Product $ 43,486 81 $ 49,797 83 $ (6,311 ) (13 )
Maintenance, support and service 13,408 77 11,219 79 2,189 20
Total gross profit $ 56,894 80 $ 61,016 82 $ (4,122 ) (7 )
* Not meaningful
The $33,000 increase in cost of product revenue was primarily due to (a) a
$198,000 increase in stock-based compensation expense, (b) a $113,000 increase
in direct product costs resulting from a slight increase in the number of
systems recognized as revenue as well as a slight decrease in the average cost
per system, (c) a $90,000 increase in depreciation and amortization expense, and
(d) an $84,000 increase in other taxes and fees. These increases were offset by
a $413,000 decrease in other cost of goods sold related to changes in the
Company's inventory reserves.
The $952,000 increase in cost of maintenance, support and service revenue was
primarily due to (a) a $295,000 increase in stock-based compensation expense,
(b) a $269,000 increase in costs associated with performance of our maintenance
and warranty obligations, (c) a $159,000 increase in salaries and related
benefits corresponding to a 16% increase in employee headcount for our services
organization to support our rapidly growing customer base, and (d) a $77,000
increase in facilities costs and related overhead.
Product gross margin decreased by two percentage points, primarily due to a
decrease in the average selling price of our systems due to changes in our
product software configuration mix, including software upgrades and the mix of
system platforms purchased by our customers partially offset by a slight
increase in the number of systems sold.
Gross margin on maintenance, support and service revenue decrease by two
percentage points, primarily due an increase in costs associated with the
performance of our maintenance obligations without a corresponding increase in
maintenance, support and service revenue, which resulted in maintenance, support
and service costs being absorbed by a lower revenue base.
We expect cost of product, maintenance, support and service revenue each to
increase at approximately the same rate as the related revenue for the
foreseeable future. As a result, we expect that gross profit will increase, but
that the related gross margin will remain relatively consistent with historical
rates for the foreseeable future.
Operating Expenses
Three Months Ended March 31,
2012 2011
Percentage Percentage Period-to-Period
of Total of Total Change
Amount Revenue Amount Revenue Amount Percentage
(dollars in thousands)
Sales and marketing $ 31,002 44 % $ 23,703 32 % $ 7,299 31 %
Research and development 15,097 21 11,294 16 3,803 34
General and administrative 6,438 9 4,577 6 1,861 41
Merger and integration-related costs 37 * 180 * (143 ) (79 )
Total operating expenses $ 52,574 74 % $ 39,754 54 % $ 12,820 32
* Not meaningful
The $7.3 million increase in sales and marketing expense was primarily due
to (a) a $3.0 million increase in stock-based compensation expense, (b) a
$2.0 million increase in salaries, commissions and other benefits associated
with a 27% increase in the number of sales and marketing personnel, (c) a
$689,000 increase in training costs, (d) a $474,000 increase in third party
services, (e) a $458,000 increase in travel and entertainment expenses
reflecting the aforementioned increase in related headcount, (f) a $301,000
increase in depreciation and amortization expense primarily due to capital
expenditures for evaluation systems, (g) a $234,000 increase in facility costs,
and (h) a $107,000 increase in expenditures associated with marketing programs
including trade shows. The balance was due to increased overhead associated with
increases in sales and marketing personnel. We expect sales and marketing
expense to continue to increase in absolute dollars and will remain relatively
consistent as a percentage of total revenue for the foreseeable future as we
expand our sales force to continue to increase our revenue and market share.
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The $3.8 million increase in research and development expense was primarily due
to (a) a $2.3 million increase in stock-based compensation expense, (b) a
$715,000 increase in salaries and other benefits associated with a 10% increase
in the number of employees working on the design and development of new products
and enhancement of existing products, quality assurance and testing, (c) a
$238,000 increase in spending on engineering supplies, (d) a $235,000 increase
in depreciation and amortization expense, and (e) a $219,000 increase in third
party services. The addition of personnel and our continued investment in
research and development were driven by our strategy of maintaining our
competitive position by expanding our product offerings and enhancing our
existing products to meet the requirements of our customers and market. We
expect research and development expense to increase in absolute dollars and will
remain relatively consistent as a percentage of total revenue, with historical
rates, for the foreseeable future.
The $1.9 million increase in general and administrative expense was primarily
due to (a) a $1.2 million increase in stock-based compensation expense, (b) a
$226,000 increase in legal fees, (c) a $234,000 increase in audit and tax fees,
(c) a $164,000 increase in taxes and other fees, and (d) a $162,000 increase in
bad debt expense. The balance was due to increased facility and overhead costs.
We expect general and administrative expense to continue to increase in absolute
dollars as we invest in infrastructure to support continued growth and incur
expenses related to being a publicly traded company. However, we expect general
and administrative expense will remain relatively consistent as a percentage of
total revenue, with historical rates, for the foreseeable future.
During the first quarter of 2012, we incurred $37,000 of merger and
integration-related costs associated with our acquisition of IPTEGO, GmbH, which
closed on April 25, 2012. During the first quarter of 2011, we incurred $180,000
of merger and integration-related costs associated with our acquisition of
Newfound Communications, which closed on January 20, 2011.
Other Income (Expense)
Three Months Ended March 31,
20112 2011
Percentage Percentage Period-to-Period
of Total of Total Change
Amount Revenue Amount Revenue Amount Percentage
(dollars in thousands)
Interest income $ 115 * % $ 210 * % $ (95 ) (45 )%
Other expense (21 ) * (108 ) * 87 (81 )
Total other income, net $ 94 * % $ 102 * % $ (8 ) (8 )
* Not meaningful
Interest income consisted of interest generated from the investment of our cash
balances. The decrease in interest income was primarily due to a decrease in the
average interest rate partially offset by an increase in the average cash
balance in the three months ended March 31, 2012.
Other expense primarily consisted of foreign currency translation adjustments of
our international subsidiaries and sales consummated in foreign currencies. The
decrease in expense from 2011 to 2012 was primarily due to fluctuations in the
value of the Euro and British Pound.
Provision for Income Taxes
Three Months Ended March 31, Period-to-Period
2012 2011 Change
Percentage Percentage
of Total of Total
Amount Revenue Amount Revenue Amount Percentage
(dollars in thousands)
Provision for income taxes $ 1,985 3 % $ 7,655 10 % $ (5,670 ) (74 )%
For the three months ended March 31, 2012 and 2011, our effective tax rates were
45% and 36%, respectively. The higher effective tax rate in the three months
ended March 31, 2012 was primarily related to the expiration of the federal
research and development tax credit as of December 31, 2011, as well as the fact
that income before provision for income taxes was significantly lower for the
three months ended March 31, 2012 as compared to March 31, 2011, resulting in
greater effects on the effective tax rate of reconciling items.
Liquidity and Capital Resources
Resources
Since 2005, we have funded our operations primarily with the growth in our
operating cash flows, and more recently, we have supplemented our cash flows
from the exercise of stock options. In October 2006, we completed an IPO and
raised $83.2 million in net proceeds after deducting underwriting discounts and
commissions. To date we have not used nor designated any of the proceeds from
our IPO.
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Key measures of our liquidity are as follows:
As of and
for the
Three As of and for
Months the Year
Ended Ended
March 31, December 31,
2012 2011
(in thousands)
Cash and cash equivalents $ 128,151 $ 160,403
Short and long-term investments 273,164 211,768
Accounts receivable, net 60,568 59,739
Working capital 407,740 391,816
Cash provided by operating activities 26,695 55,341
Cash used in investing activities (65,472 ) (49,036 )
Cash provided by financing activities 6,525 62,429
Cash, cash equivalents, short and long-term investments. Our cash and cash
equivalents at March 31, 2012 were invested primarily in high quality securities
and are not materially affected by fluctuations in interest rates. Our short and
long-term investments consist of high quality government treasuries and bonds.
The cash and cash equivalents are held for working capital purposes. We do not
enter into investments for trading or speculative purposes. Restricted cash,
which totaled $69,000 at March 31, 2012 and December 31, 2011, is not included
in cash and cash equivalents, and was held in certificates of deposit as
collateral for letters of credit related to the lease agreements for our sales
office in Madrid, Spain.
Accounts receivable, net. Our accounts receivable balance fluctuates from period
to period, which affects our cash flow from operating activities. The
fluctuations vary depending on the timing of our shipments and related invoicing
activity, cash collections, and changes in our allowance for doubtful accounts.
In some situations we receive a cash payment from a customer prior to the time
we are able to recognize revenue on a transaction. We record these payments as
deferred revenue, which has a positive effect on our accounts receivable
balances. We use days sales outstanding, or DSO, calculated on a quarterly
basis, as a measurement of the quality and status of our receivables. We define
DSO as (a) accounts receivable, net of allowance for doubtful accounts, divided
by (b) total revenue for the most recent quarter, multiplied by (c) 90 days. DSO
was 77 days at March 31, 2012 and 65 days at December 31, 2011. The increase in
DSOs from the fourth quarter of 2011 to the first quarter of 2012 was primarily
related to the continued aging of receivables. While we believe that all of
these receivables remain collectible, we have recorded additional allowances for
uncollectible accounts in accordance and consistent with our historic
methodology.
Operating activities. Cash provided by operating activities primarily consists
of net income adjusted for certain non-cash items including depreciation and
amortization, impairment of intangible assets, deferred income taxes, provision
for bad debts, stock-based compensation, offset by the associated excess tax
benefit, and the effect of changes in working capital and other activities. Cash
provided by operating activities in the three months ended March 31, 2012 was
$26.7 million and consisted of (a) $2.4 million of net income, (b) non-cash
deductions of $15.2 million consisting primarily of $13.7 million of stock-based
compensation, $3.0 million of depreciation and amortization, $337,000 in
amortization of premium/discount on investments and $216,000 in provisions for
bad debts all of which were partially offset by a deduction of $2.0 million
related to the tax savings from the exercise, by employees, of stock and
(c) $9.1 million provided by working capital and other activities. Cash provided
by working capital and other activities primarily reflected a $12.8 million
increase in deferred revenue, a $1.7 million increase in accrued expenses and
other liabilities and a $651,000 decrease in deferred product costs, partially
offset by a decrease of $3.2 million in accounts payable, an increase of
$1.0 million in accounts receivable, an increase of $1.1 million in other assets
and a $757,000 increase in inventory.
Investing activities. Cash used in investing activities in the three months
ended March 31, 2012 was $65.5 million, which included $214.5 million in
purchases of marketable securities and $3.7 million in purchases of property and
equipment all partially offset by $152.8 million from the maturities and sales
of marketable securities.
Financing activities. Net cash provided by financing activities in the three
months ended March 31, 2012 included proceeds from the exercise of common stock
options in the amount of $4.5 million and $2.0 million of excess tax benefits
from the exercise of stock options.
Anticipated cash flows. We believe our existing cash, cash equivalents and short
and long-term investments and our cash flow from operating activities will be
sufficient to meet our anticipated cash needs for at least the next twelve
months. Our future working capital requirements will depend on many factors,
including the rate of our revenue growth, our introduction of new products and
enhancements, and our expansion of sales and marketing and product development
activities. To the extent that our cash, cash equivalents, short and long-term
investments and cash flow from operating activities are insufficient to fund our
future activities, we may need to raise additional funds through bank credit
arrangements or public or private equity or debt financings. We also may need to
raise additional funds in the event we determine in the future to effect one or
more acquisitions of businesses, technologies and products that will complement
our existing operations. In the event additional funding is required, and given
the current condition of the global financial markets, we may not be able to
obtain bank credit arrangements or affect an equity or debt financing on terms
acceptable to us or at all.
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Requirements
Capital expenditures. We have made capital expenditures primarily for equipment
to support product development, evaluation systems for sales opportunities,
improvements to our leased corporate headquarters in Bedford, Massachusetts,
development of a new enterprise resource planning system and other general
purposes to support our growth. Our capital expenditures totaled $3.7 million in
the three months ended March 31, 2012. We estimate capital expenditures of $16.0
- $18.0 million in the remainder of 2012.
Contractual obligations and requirements. Our only material contractual
obligation relates to the lease of our corporate headquarters in Bedford,
Massachusetts.
Off-Balance-Sheet Arrangements
As of March 31, 2012, we did not have any significant off-balance-sheet
arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
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